Ready, steady, wander…
With Turquoise poised to start testing in August followed by ‘live’ roll out in September, many organisations appear woefully unprepared in terms of testing their back-, middle- and front-office systems. Not only are they missing an opportunity to reduce transaction costs, argues Jerry Lees, head of alternative execution at Cheuvreux, they are also falling short on delivering best execution.
It seems staggering to me how complacent so many organisations appear to be in the current environment, especially the incumbent exchanges. But also, brokers are ignoring the opportunity to reduce transaction costs, get inside the regulated market spread and in so doing deliver quantifiable benefits in terms of their execution costs and alpha both for themselves and their clients. Meanwhile, the exchanges seem to keep on hoping that Turquoise will never happen, or Chi-X will go away. When will they get to grips with the fact that liquidity is going to be seriously fragmented and prices will have to come down by a factor of 10 if they are to stay competitive? No one is really interested in the incumbent exchange’s legacy system issues or over- manning problems – they have plenty of other profitable business lines. I believe the exchanges need to react and react quickly or see permanent damage to their equity revenue streams.
Lessons from Chi-X
There is an obligation for best execution. Currently, Chi-X offers a reduced execution cost both in terms of significantly lower transaction fees and marked spread improvement for up to 10% of key market index stocks. Why then are so few taking advantage of this? How can any market participant justify not responding to this opportunity in line with MiFID best execution objectives? I am not particularly trying to blow Chi-X’s rumpet, but if organisations are not testing their systems on Chi-X now in readiness for Turquoise and the like, when are they going to get around to it? When it’s too late!
Chi-X has been a useful exercise for everyone participating; it has allowed us to highlight unforeseen problems with both internal and external systems in readiness for Turquoise and other new MTFs. We have been able to isolate unexpected issues within our smart order routers and fine-tune them to deal with differing practices between Chi-X and the underlying markets. We have had to identify and create workarounds in middle- and back-office systems to allow us to settle with our clients in an efficient manner, while we address longer term solutions. And we have identified and gone some way to understanding and solving problems related to various EMS systems, which have been woefully inadequate in preparing for the changes related to Chi-X and other MTFs.
Those of us who got started some time back with Chi-X are now reaping the cost benefits both for our-selves and for those clients ready to get involved. Those who are only planning to get involved when Turquoise comes along will – I believe – struggle. They will have to solve many of the issues we have had to face with getting Chi-X fully operable since its launch last April. While we were ready to go, outstanding problems had to be resolved related to external systems, vendors and clients’ back- and middle-office operations.
The issues we had to fix ranged from basic problems at both sell- and buy-side clients, such as not being able to handle two commission rates on one trade, decisions on what symbol to settle against when the trade is split between two symbols (VOD.L or VOD.X), to the assumptions made by the smart order routers when trading rules are different on different exchanges. The most exasperating issues however related to the EMS system vendors who (with notable exceptions such as Bloomberg) have not covered themselves in glory. They just were not ready and totally underestimated the job in hand or in one case (I will not mention them by name) rather belligerently failed to cooper-ate. The impact: we are still unable to implement properly with more than half of the clients on their EMSs.
Progress report
Considerable progress has been made in a number of areas however. Smart order routers are working well and additional refinements – based on experience – are allowing us to extract better performance out of the new liquidity pools. We have connected to the Euro Millennium dark pool, with more dark pools to follow and with two of our own in the offing. We have also discovered an unexpected additional arbitrage, which we – and our clients – are very happy with. We are steadily educating and rolling out to all users who are ready (there is an extensive education process here for many traders) and the process is pretty smooth as we can advise on the issues and put the necessary steps or workarounds in place in advance.
We are excited by the prospect of Turquoise and Equiduct and look forward to significant market benefits. I hope the exchanges are prepared for the impact, since I believe they will see significant flows migrate elsewhere. They will have to react to this by restructuring their pricing models very quickly, possibly before Turquoise goes live.
